In my view, Starbucks is one of the most overvalued stocks on the Street. Though it is a well-run company, its price tag of 27.2x is at a considerable premium to Dunkin's 24.4x, McDonald's 17.1x, and GMCR's 10.2x. If management fails to achieve the 18.5% annual EPS growth forecast set by the Street, we should see multiples start to contract. Given that the stock has a beta of 1.2, this magnifies just how much we can expect the contraction to be.
In short, I recommend avoiding the stock. McDonald's possible entry into Starbucks’ arena may put a wrench into the premium brand's ability to achieve its double-digit forecast. For years, Starbucks has struggled under the reputation of being overly expensive coffee for elusively better quality. McDonald's is well known for standardization and, ironically, quality tends to accompany this. When you order a coffee at McDonald's, you know what you are getting and look forward to it. This predictability is quality in it is own right, and, at a low prices, it's potentially worth buying over Starbucks’ bagged coffee.
Coffee prices have been very volatile in recent years, but both McDonald's and Dunkin have secured low prices. Management at Starbucks has hedged against volatility through the futures market, but this has come at the cost of reducing upside. In the third quarter, revenue grew to $0.36 per share, which was well below the $0.45 per share Street forecast. Expansion into India looks good, given the 31% third quarter growth in Asia (which now makes up 13% of the bottom-line), but, at this point, you would have to buy at elevated prices to gain exposure. Accordingly, I recommend holding out.
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